Sensitivity to commodity prices as well as regional economic cycle and geopolitics (landlocked country)

RISK ASSESSMENT

Fast growth highly reliant on agriculture, hydropower and mining

The industrial sector, including especially hydropower exploitation, construction and mining, is cornerstone to growth. Hydropower will boost GDP growth via the construction sector given the extensive number of dam projects. In 2019, the Xayaburi and Don Sahong dams will be completed, increasing the electricity output. However, if at least nine other projects are currently underway, some – such as the one in Pak Lay – are pending approval from the Mekong River Commission (MRC), especially after heavy rains caused a dam to burst in 2018, leading to a heavy death toll and thousands of displaced people. Electricity already accounts for a quarter of exports, notably thanks to fast growing demand from Thailand. Construction projects rely largely on China, which is responsible for around half of the investments in the hydropower sector and 70% of the funds for the high-speed train being built across the country, which is expected to be completed in 2021.

The tourism sector will contribute to growth of the services industry in 2019, although it will remain below potential, with 80% of tourists coming from South East Asia. In that view, the government will continue to invest in tourism infrastructure (with the construction of a fifth airport and hotel facilities). Moreover, despite lacking productivity and profitability, agriculture will continue to account for 30% of GDP and 60% of the workforce. In 2019, household consumption will stall because of surging inflation, even if the government intends to mitigate price pressure on food prices. Consumer price growth will accelerate due to the pick-up in global food and oil prices, insufficient crop harvests, and the weakness of the kip inducing imported inflation.

Exposure to external shocks via high external debt levels and current account deficit

The fiscal deficit will remain high despite consolidation efforts. Revenues are limited by low tax rates, a small tax base, and corruption. Over 10% of revenues come from international grants. Furthermore, the country is over-indebted to China (at least half of public debt). The high and increasing level of government debt is concerning, especially considering that 80% of it is denominated in foreign currency and externally held, although a lot of it is in concessional terms (85%). This level of external reliance poses a sustainability risk in a context of global monetary tightening and depreciation pressures on emerging markets’ currencies. Exposure to external shocks is increased by the total external debt level (around 120% of GDP) – although it is mostly comprised of FDI liabilities – and the fact that the banking sector is fragile and highly dollarised. Moreover, Laos does not have a satisfactory level of foreign exchange reserves to cushion these risks (around one month of imports).

The current account deficit will remain very high, which exposes the country in case of further depreciation of the currency or fluctuations in commodity prices. The merchandise trade balance is under a structural deficit. Export growth will be helped by higher copper prices and the increased output of electricity, but will remain far from enough to compensate the import bill, which is growing due to capital goods imports in relation to construction projects. At the same time, the balance of services (specifically the tourism sector) should in part offset the repatriation of dividends by the foreign companies involved in the exploitation of natural resources. The country also receives foreign aid and remittances from expatriate workers.

Political stability despite major development challenges

The communist-inspired Lao People's Revolutionary Party (PPRL) is the only authorised party. Stability and continuity is ensured by censorship and repression of political rallies. Ranked 154 out of 190 in the World Bank Doing Business report, the country suffers from a lack of rule of law, high corruption levels, and a judicial system that is not independent from the ruling party. Moreover, despite the strong growth seen over recent years, the country remains underdeveloped as governance favours the external market and FDIs that bring little benefit to the population, since the public authorities prioritise infrastructure over health andeducation.

Another governance challenge stems from social unrest against dam construction after the flooding disaster in 2018; the death toll of which the authorities are suspected to have purposefully underestimated. The choice of hydropower as a development nexus will also have to face the challenge of assessing and handling impacts in downstream regions, such a Vietnam and Cambodia, while the MRC and its member-countries countries still lack processes and expertise.